Internal Revenue Service: The new health care police

If Congress has its way, once their new health bill is signed, sealed, and delivered, most Americans will be required to have health insurance, and that will bring with it a whole new level of administrative duties. Someone will have to serve as the health care police. So far, it appears those tasks will fall to the IRS. With a less than stellar record in meeting its primary duties -– by its own report, in 2005 it failed to collect over $290 billion in taxes owed -- this has a lot of people scratching their heads.

Take a look at some of the new tasks that will be required once the health law takes effect. According to Kaiser Health News this will involve:

Monitoring compliance. Taxpayers will have to provide proof of coverage with their annual federal tax returns. Failure to comply will result in a penalty, payable to the IRS.

Distributing new government subsidies to low-income individuals through newly created state exchanges.

Overseeing small business tax credits to help qualifying businesses provide insurance to employees.

Assessing a tax on insurers that provide insurance benefits that are high-cost, or “Cadillac” plans.

Enforcing penalties for improper distributions from Health Savings Accounts, which Kaiser says will increase under the new plan.

Overseeing the demand that not-for-profit hospitals live up to their “charitable missions” by doing a “charitable needs assessment” once every three years.

Regulating contributions to Flexible Spending Accounts, which Kaiser estimates will be limited.

In addition the Congressional Budget Office (CBO) says that the tax agency will also collect new fees levied on employers, drug makers, device manufacturers and health insurance providers. This could amount to hundreds of billions of dollars, says the CBO.

So why the IRS?

Actually, even critics of the plan say that, in some ways, this makes sense. CPA David H. Williamson, of Redding, California admits, “Given the current plan to subsidize health insurance for those who can't afford it by issuing refundable tax credits, the IRS is the logical agency to perform this function.” Even so, he does not support the idea for various reasons, beginning with the tax agency’s record. “The IRS has a difficult time fulfilling the role they have now. How successful are they going to be with this huge additional responsibility?”

Nina E. Olson, the National Taxpayer Advocate, expressed a similar view. Every year she is required to submit to Congress a report detailing the top 20, or more, of the biggest headaches taxpayers face with the IRS. In her most recent report she listed 21 significant problems and dozens of administrative and legislative issues. With this in mind, she expresses concern that the already beleaguered IRS -– which is facing budget cuts, staffing shortages, and an outdated computer system –- will now be burdened with a greatly increased workload.

Senator Charles Grassley (R-IA),the top Republican on the Senate Finance Committee, is opposed to the bill in general, and the IRS involvement in particular. "It’s hard to see how the IRS could take on the huge responsibility it would be given under pending health care legislation without some real glitches, or worse.” Grassley and every other Republican Senator voted against the health bill.

Making the prognosis worse is the fact that so far, neither the House nor Senate version of the health bill has addressed funding to cover the administrative functions. In a letter to Representative John Dingell (D-MI), the CBO estimated that, to fulfill the duties associated with this new law, the IRS will need somewhere between $5 billion to $10 billion in additional money over the first decade. Currently their annual budget is about $11.5 billion. Presumably funding will be hammered out by House and Senate negotiators as they seek to finalize the bill.

Social programs

Using the tax agency as the muscle behind various social programs is nothing new. Howard Gleckman of the Urban Institute says making the IRS serve as the health care police this is part of a historical pattern.

"We are always asking the IRS to do all kinds of social engineering," he said, citing as examples the earned income credit, and more recently the homebuyer credit. The government decides on a preferred behavior, and then creates tax credits to reward that behavior and sometimes tax penalties to discourage noncompliance, as with the health care bill. That social engineering gives rise to complaints that the IRS is involved in areas that it does not belong and has no competence.

For example, Williamson points out that this new law may put the IRS in the position of determining what is “acceptable” health insurance. “Are they going to require tax preparers to help make that determination? Will the IRS certify a health insurance plan as acceptable?” One might ask, what qualifies a tax agency to make these judgments?

Under the new health bill, the IRS will be empowered to decide who qualifies for the insurance subsidies and who does not. The subsidies would apply to individuals with incomes up to $43,320 (which is four times the federal poverty rate) and families of four up to $88,200. The government will then give money to insurance companies to help recipients buy insurance through “exchanges,” which are a sort of health plan marketplace for small businesses and for people who do not get coverage through their employers.

Generally speaking, the Internal Revenue Service record as an administrator of social programs has not always inspired confidence. But at least one voice thinks the agency can handle it. John Dalrymple, a former deputy commissioner of the IRS, says the tax agency’s significant experience in administering a tax credit program, such as the Earned Income Credit, bodes well for the IRS’s ability to take on the duties involve in the health care subsidy.

Refundable credits: if the system leaks money why use it?

Beyond the issues of putting this enormous new burden on an already troubled agency, and using the IRS as an agent of social engineering, many are questioning the design of the health care credit. The design includes offering refundable tax credits as a way to subsidize health insurance for those who can’t afford it.

Williamson is among those who want to know why the IRS continues to distribute money through credit programs that leak cash. “How are they going to prevent the kind of fraudulent tax returns that we currently see because of refundable tax credits like the Earned Income credit?”

Here’s a look at how the IRS has fared in recent years with programs involving credits – refundable and otherwise.

The Earned Income Credit – which Senator Grassley says is “rife with fraud and abuse” -- was created in the 1990s in an effort to shift income directly to the poor. When the Treasury Inspector General for Tax Administration (TIGTA) took an in depth look at the Earned Income Credit program, it was determined that in the year in question –- 2005 -- more than 22 million people claimed the credit, for a total of over $40 billion paid out. Of that, says TIGTA, $11.4 billion, or 28%, were improper.

TIGTA’s review of the Hope Credit revealed that $612 million was improperly paid out over a four-year period, mostly due to flaws in the way documentation is collected and processed.

During the same four year period (2004-2007) the Child Tax Credit program lost approximately $7 billion in improper payments. TIGTA says the key weakness with the Child Tax Credit is in the issuance and use of individual tax identification numbers (ITINs). This, in spite of the fact that the law is clear about the criteria to get an ITIN and the limited usefulness of this type of identification.

Most recently, the First Time Home Buyer Credit program has been shown to be full of holes. In its first few months of existence, this credit resulted in $636 million in bogus payouts, including one credit paid to a four year old child who was identified as a first time home buyer.

In Nina Olson’s annual report to Congress for 2009, she noted that, “Refundable credits have been associated with high overclaim rates.” She goes on to say that the “refundable nature of the credit is not the primary driver of the noncompliance.” It is her opinion that the flaw is in the design, which generally does not include sufficient documentation.

What does the IRS have to say about the new responsibilities?

Last fall, AccountingWEB Managing Editor Gail Perry had a chance to question IRS Commissioner Doug Shulman at the AICPA National Tax Conference in Washington, DC. She asked him what he thought the biggest challenge would be for his agency if health care legislation passed and the IRS became the watchdog for administering the program.

Shulman’s answer was vague, though upbeat in the face of a greatly increased workload. “What I would say about health care is this: I agree with the president that it should be a top priority, health care reform is important, and whatever it is at the end of the day that Congress passes and the president signs, the IRS will sign up for and will do its part.”

The Massachusetts model

Not all views of the upcoming bill are negative. In 2007 Massachusetts became the first state to mandate health insurance. State residents must include a special form with their state tax returns on which they report their insurance status. Insurance companies provide policyholders with “proof of coverage” statements and report coverage to the state’s Department of Revenue.

Robert Bliss, a spokesman for the Massachusetts Department of Revenue told reporters at Kaiser Health News that the agency absorbed the new duties without any extra funding or staff, and has not encountered serious difficulties. Part of the credit for that, says Bliss, is the fact that the department had 18 months to prepare for the change. He points out that the IRS has three to four years to get ready.

How is the plan working out in Massachusetts? Bliss says that in 2008, no-coverage penalties were assessed against only 1.3% of filers, while more than 96% provided proof of coverage. Overall, the health insurance mandate lowered the percentage of uninsured from 7% to 4%.

The Massachusetts model doesn’t answer all the concerns, but it does at least provide some reason to hope that, with enough time to prepare, the IRS might be able to handle its new burdens with a minimum of chaos.